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What Is a Debt-to-Equity Swap?

In a debt/equity swap, a lender receives an equity interest such as shares of stock in the company in exchange for the cancellation of a company’s debt to them. Under Swiss law, debt restructuring may occur out of court, or through a court-mediated debt restructuring agreement that may provide for a partial waiver of debts, or for a liquidation of the debtor’s assets by the creditors. Economist Joseph Stiglitz testified that bank bailouts “are really bailouts not of the enterprises but of the shareholders and especially bondholders. There is no reason that American taxpayers should be doing this”.

  • Equity is money that’s invested in a corporation or enterprise by owners who are called shareholders.
  • A week after Scandinavian Airlines revealed plans to convert US$2.1 billion of its debt into equity and raise almost US$1 billion of cash, the Swedish government announced it will not inject new capital into the struggling company.
  • The good news is that the programme has expanded in scale over time, with 40% of the total signed-swap value executed by April 2019.
  • This is a situation of debt/equity swap wherein the borrower asks its lender to exchange the existing debt for equity.
  • Typically, a release of debt by an unconnected lender will result in a taxable accounting profit for the borrower.

There are certain uses of Debt/Equity Swap due to which it is one of the important tools used by lenders and debt holders to navigate the business during stressful times or where the business is on the verge of bankruptcy. Debt equity swap has various implications which include dilution of equity interest in the business, impacting the earnings per share of the business , reduction in fixed interest expense of the business on account of debt conversion into equity. In such cases, lenders have to take a call that whether liquidating the business makes more sense or Debt/Equity swap will be more beneficial for all. Also by entering into a debt/equity swap the lenders to business can gain more if business turnaround contrary to the fixed interest payment they would have received on their debt to the business in the ordinary course of business. The equity interest may be a specified number of shares or a number of shares equal to a certain dollar amount.

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The company takes the lead role on preparing and negotiating the documents necessary to effect the debt for equity swap, including debt forgiveness, share issue and shareholder agreements. The positive effects of debt-equity swaps are that they decrease or settle the company’s over-indebtedness, improve the balance sheet structure (i.e., the debt to equity relationship) and, therefore, improve the company’s credit standing.

What are the advantages of debt swap?

By swapping its debt, the debtor country reduces its obligations to make foreign currency payments by the extent of the conversion. By reducing contractual claims on scarce foreign exchange, debt swapping allows the country to relax its foreign exchange constraint and to reduce the rigidity of its balance of payments.

We consider a situation in which a corporate manager’s investment decision is affected by the firm’s debt level. Although both an equity-for-debt swap and convertible debt can induce the self-interested manager to undertake only value-increasing projects through capital structure adjustments, there exists a significant difference between these two financial instruments. An equity-for-debt swap, which requires the agreement of both shareholders and debt holders, can change a firm’s debt level only prior to the manager’s investment decision. On the other hand, convertible debt, which gives debt holders a unilateral right to convert, can change a firm’s debt level even after the manager’s investment decision. A debtor that issues new shares to the creditor as part of the debt-to-equity swap may suffer a reduction of its tax losses.

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To a large degree, the negotiating position will depend on the granularity of the creditor group. The more the company needs to rely on the buy-in of only a few creditors, the more bargaining power they will have when it comes to the terms of the reinstatement. Similar to the modification of debt, the agreement on the terms of the reinstatement of the debt can be rather complex. From a tax and accounting perspective, such transaction is treated as a full waiver and the creation of new debt once the reinstatement takes place. Other jurisdictions outside Germany do not treat a waiver with a conditional reinstatement as a waiver of debt, but rather as an amendment to the payment terms of the instrument. As an alternative to a waiver, the terms of the debt may be amended so any repayment is contingent on certain conditions being satisfied.

Not only is debt reduced along with interest payments, but equity is simultaneously increased. Investors can then have more confidence that the bank is solvent, helping unfreeze credit markets. Taxpayers do not have to contribute dollars and the government may be able to just provide guarantees in the short term to buttress confidence in the recapitalized institution. For example, Wells Fargo owed its bondholders $267 billion, according to its 2008 annual report. A 20% haircut would reduce this debt by about $54 billion, creating an equal amount of equity in the process, thereby recapitalizing the bank significantly. It aims at clarifying the circumstances under which it is appropriate to cancel, transfer, or severely dilute shares or other instruments of ownership.

Debt/Equity Swaps vs. Equity/Debt Swaps

The debt waiver is often part of a package of relief used in an effort to ensure the survival and prospects of the debtor. The sale of distressed debt is a mechanism for a creditor to reduce their balance sheet exposure to debts which may currently be non-performing or have a significant risk of future default. In such circumstances, the debt would be sold at a discount to face value in view of the distressed financial circumstances of the debtor. Norton Rose Fulbright has performed research across selected jurisdictions (i.e. the US, Australia, Canada, South Africa, France, the UK, Germany, Luxembourg and the Netherlands) on various debt restructuring scenarios and the local tax impact on debtors and creditors. This research has provided us with insight into various pitfalls that might occur from international debt restructurings. Companies that make use of a debt/equity swap are typically in severe financial distress, whether from cash flow problems, business losses, or a substantial decline in revenues or income. They are sometimes conducted during bankruptcies, and the swap ratio between debt and equity can vary based on individual cases to write off money owed to creditors.

After significant discussion the IFRIC members noted that even though they believe that the proposed view is the only acceptable interpretation given the current IFRS requirements, there is need for clarification of the requirements. After assessing the issue against the agenda criteria the IFRIC decided to take the issue on the agenda and develop and interpretation of the standard to make it clear that the proposed accounting treatment is the only solution. As such it asked its chairman to consider the possibility to have a video conference to facilitate drafting of the interpretation in August. Over the What Is a Debt-to-Equity Swap? past few years, businesses have been hit by a wave of class actions alleging that ubiquitous marketing-analytics technology used on modern websites—including many federal court websites—violates federal and state wiretapping laws. By undertaking this exercise the company will save yearly interest outgo of 0.1 million on its debt obligation which will help the business to retain profits and improve its liquidity. The company is also saved from the negative image that arises when it is not able to repay the debts. Learn financial modeling and valuation in Excel the easy way, with step-by-step training.

Lender-led debt restructurings: key points to be aware of

Such companies, given that they just scrape by meeting overheads , have no excess capital to invest to spur growth. Arguably, the fact that China has released this policy at a time of heightened Sino-US tensions, especially over technology, speaks volumes about its confidence in its role and influence on the global stage. From a global perspective, efforts to formalise party control of the private sector represent a potential disruption to the international trade framework.

What Is a Debt-to-Equity Swap?

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